Tension brewing between one of the world’s oil-producing powerhouses and a neighboring rival looking to gain market share has the energy sector keeping closer eyes on potential implications as Chinese demand slows and product inventories rise.

Some believe the strained relations of Saudi Arabia and Iran are not impacting the price of crude oil as it would have in the past, given the world’s abundant supplies. But the situation could change if sour relations spill into matters concerning oil and gas production, analysts said.

“Continued tension between Iran and Saudi Arabia could potentially place further downward pressure on the oil price in the short-to-medium term, should it impact cooperation within OPEC,” said Katy Smith, a researcher for Douglas-Westwood. “Notably, any future decisions to constrain output in order to support the oil price would likely require the agreement of both Saudi Arabia and Iran.”

The latest sectarian fallout between the Shi’ite Iran and Sunni-ruled Saudi Arabia follows the Jan. 2 execution of Shiite cleric Nimr al-Nimr, among others, by the Saudis. Iranian protesters responded, diplomatic ties between two countries broke and on Jan. 7, Iran accused Saudi warplanes of hitting its embassy in Yemen, according to news reports worldwide.

The conflict has not significantly rattled the oil market. Unlike financial woes in China and its devalued yuan, which sent the market into a momentary frenzy as oil prices dipped then recovered.

But Smith pointed out the recent fluctuation in oil prices, “with the price of Brent crude briefly having risen to $38.50/bbl, its highest level for three weeks, then being followed by a drop to below $33/bbl, due to concerns over rising product inventories and weakening Chinese demand growth.”

Smith added “these developments have potentially significant repercussions for the oil and gas industry.”

Supply along the Strait of Hormuz, which she said accounts for about 30% or 17 MMbbl/d of oil transported via maritime routes, could take a direct hit.

Production, Supplies

Escalating tension in Middle East comes as Iran works to ramp up oil production and exports after world powers agreed to lift sanctions.

“Though the Iranian government has an ambitious target to raise its oil production to 5.7 MMbbl/d by 2018, [Douglas-Westwood] takes a conservative view, expecting total Iranian oil production to rise at a 4% CAGR through to 2021,” Smith said. “This could add further pressure on a market which is already oversupplied and pose an obstacle for other key producers within the Middle East, such as Saudi Arabia.”

Oil production in Saudi Arabia is expected to surpass 12 MMbbl/d in 2021, Douglas-Westwood said.

Though the kingdom is keen to maintain its market share, it has expressed willingness to cut production but only if others do the same.

However, “the current ramping up in tensions between Saudi Arabia and Iran only further confirms our view that Saudi Arabia is unlikely to cut its output to help Iran regain market share,” Wood Mackenzie said in a report authored by Ann-Louise Hittle, the consultancy’s head of macro oils.

In December, OPEC essentially decided to keep producing at current levels—which was about 31.3 million barrels a day (MMbbl/d) in October, more than 1 MMbbl above the ceiling it set last year then crossed.

Wood Mackenzie pointed out in the analysis Jan. 5 that global oversupply has muted the oil price response to tensions between the two Middle Eastern countries.

“From our analysis of the supply/demand fundamentals, we expect a global drawdown in stocks to begin in H2 2016 and accelerate in the fourth quarter,” Wood Mackenzie said. “With this tightening in the supply and demand balance, political risk will become more important to oil prices.”

OPEC, Non-OPEC

OPEC oil output dropped from 31.79 in November to 31.62 MMbbl/d in December on lower supply from Iraq and other producers, Reuters reported this week.

Non-OPEC production has also slowed as operators respond to the oversupply and low commodity prices. Wood Mackenzie forecasts it could fall by 0.7 MMbbl/d this year.

However, following declines, crude oil production has risen recently in the United States, where legislators in December agreed to lift the 40-year-old crude oil export ban. Figures released Jan. 6 by the U.S. Energy Information Administration show crude oil production increased 17,000 bbl/d for the week ending Jan. 1 to 9.2 MMbbl/d.

When asked about the Iran-Saudi Arabia conflict’s impact on the global energy market and reliability of the world’s energy supply, the leader of the trade association that represents the U.S. oil and gas industry pointed to the price of crude.

“It’s moved slightly, but there hasn’t been a big uptick,” Jack Gerard, president and CEO of the American Petroleum Institute said Jan. 5 following remarks about the state of America’s energy sector. “Ten years ago I believe the markets show that there would’ve been significant movement in the price of oil with the unrest that’s taking place today.”

Why is that, he asked, then answered “because the United States has come in as a major player. Things like the crude export ban being lifted put us in a position where the geopolitics and energy production around the world will never be the same unless we restrict ourselves.”

Many believe that the epicenter of power for oil and gas production is shifting to the United States, he added.

Yet, the global oversupply and low commodity price remain.

“As we face this rising geopolitical tension in early 2016, the global oil industry’s ability to respond to a potential impact on supply is weakened by the low oil prices of the last 18 months,” Hittle said in the analysis. “Oil demand growth remains relatively strong heading into 2016 with a forecast gain of 1.2 million b/d for the year.”

Velda Addison can be reached at vaddison@hartenergy.com.